Bumi Armada (BAB) announced that it has received the final acceptance certificate for FPSO Kraken. This is in line with management’s timeline shared during the 2Q18 analyst briefing. The positives from this acceptance is that earnings and cash flow certainty will be enhanced. The key focus moving forward is to rectify the remaining Kraken equipment, as production is not at optimum capacity yet. Longer term positives hinges on the quantum of impairment write back, which depends on the speed of the rectification works done. Maintain BUY call and TP of RM0.66.

Final Acceptance Details

The final acceptance of FPSO Kraken was completed in accordance with the amended agreement 2 (AA2) signed on 27 August 2018. This milestone would see BAB recognising the full BBC rate under the finance lease (FL) accounting treatment by end-18. However, this rate as we understand has been revised lower in the recently signed AA2 albeit still higher than the current rate Kraken is recognising, which is a positive. FL accounting would generally see a higher earnings and cash flow as a result of the final acceptance. On the balance sheet side, the Kraken RM1.95bn debt, which was previously re-classified from long-term to short-term (due to the miss in the previous acceptance timeline), is in the midst of negotiation for reclassification back to long term.

Kraken Field Production Slowly Ramping on

FPSO Kraken was producing at an average 31kbpd of oil in 1H18. The production level has subsequently improved to 33kbpd in July and 36kbpd in August. EnQuest has completed the subsea infrastructure installation and will be starting their DC4 campaign in 4Q18 to further ramp up production, and on track to achieving 50kbpd target in 2019.

Future Potential Write Back of Impairment

The nature of the recent impairment was a result of the potential impact of the client continent liability across FPSO Kraken’s contract tenure in the event BAB fails to rectify the vessel specification. From our understanding, the rectification will take about 1-2 years, and no actual cash outflow will take place until the rectification has been completed. The amount of write back depends on how quickly BAB can modify the specification of FPSO Kraken. No capex guidance for this has been disclosed.

Lower BBC Rate Has Been Priced in Our Forecasts

In our previous report, we had already cut our FY18-20E earnings by 20%- 25%, taking into account the lower FPSO Kraken BBC rate. Nevertheless. our FY18 forecast is still significantly above the streets as we chose to add back the US$25m penalty payable to EnQuest that will incur in 2018, which we deemed as one-off.

Maintain BUY

In our view, current share price has already factored in the worst case scenario and fully prices in the impairment charge. We believe the stronger earnings and cash flows will rerate the stock in the coming quarters. Further re-rating hinges on the impairment write back which ultimately depends on the completion of the rectification work. We maintain our BUY call with an unchanged SOTP based target price of RM0.66. Key risks to our view include: (1) termination of existing FPSO contracts, (2) delay in Kraken rectification work, and (3) failure to refinance upcoming few debt repayment.

Source: Affin Hwang Research - 12 Sept 2018